What Caused FTX To Collapse? Here’s What Happened To Sam Bankman-Fried’s Crypto Exchange

Cryptocurrency exchange FTX filed for Chapter 11 bankruptcy protection on Nov. 11, 2022, after a swift fall from grace. The company’s valuation plunged from $32 billion to bankruptcy in a matter of days, dragging down founder and CEO Sam Bankman-Fried’s $16 billion net worth to near zero.

FTX’s collapse shook the volatile crypto market, which lost billions in value, dropping below $1 trillion.3 The consequences of FTX’s rapid decline and collapse will likely impact cryptocurrencies well into the future and could even drag down broader markets.

On November 16, a class-action lawsuit was filed in a Florida federal court, alleging that Sam Bankman-Fried created a fraudulent cryptocurrency scheme designed to take advantage of unsophisticated investors from across the country. Other celebrities named in the lawsuit include Steph Curry, Shaquille O’Neal, Shohei Ohtani, Naomi Osaka, Larry David, and Kevin O’Leary who allegedly helped Bankman-Fried facilitate the plan.

The U.S. House Financial Services Committee said it will hold a hearing in December 2022 on the FTX collapse.

Below, we explore what went wrong with FTX.

Sam Bankman-Fried, founder and CEO of FTX.
Sam Bankman-Fried, founder and CEO of FTX.

Launched by Sam Bankman-Fried when he was just 28, FTX became one of the largest crypto exchanges in just three years with a valuation of $32 billion. Bankman-Fried used aggressive marketing, including a Super Bowl ad campaign, and the purchase of naming rights to the home of the Miami Heat basketball team. He became known for his political lobbying and donations as well as for working to support the cryptocurrency industry more broadly. As values plunged in early 2022, he facilitated deals totaling about $1 billion to bail out cryptocurrency companies struggling as a result of the declines in token prices.67

What Happened to FTX?

FTX’s collapse took place over a 10-day period in Nov. 2022. The catalyst for the crisis was a Nov. 2 scoop by CoinDesk that revealed that Alameda Research, the quant trading firm also run by Bankman-Fried, held a position worth $5 billion in FTT, the native token of FTX. The report revealed that Alameda’s investment foundation was also in FTT, the token that its sister company had invented, not a fiat currency or other cryptocurrency.8 That prompted concern across the cryptocurrency industry regarding Bankman-Fried’s companies’ undisclosed leverage and solvency.

Binance Says It Will Sell FTT Tokens

Binance, the world’s biggest crypto exchange, announced on Nov. 6 that it would sell its entire position in FTT tokens, roughly 23 million FTT tokens worth about $529 million. Binance CEO Changpeng “CZ” Zhao said the decision to liquidate the exchange’s FTT position was based on risk management, following the collapse of the Terra (LUNA) crypto token earlier in 2022.

FTX Liquidity Crisis and Binance Deal

By the next day, FTX was experiencing a liquidity crisis. Bankman-Fried attempted to reassure FTX investors that its assets were stable, but customers demanded withdrawals worth $6 billion in the days immediately following the CoinDesk report. Bankman-Fried searched for additional money from venture capitalists before turning to Binance. The value of FTT fell by 80% in two days.

On Nov. 8, Binance announced it had reached a non-binding agreement to buy the non-U.S. business of FTX for an undisclosed sum, effectively the world’s largest cryptocurrency exchange bailing out its close rival.

Binance Cancels Deal to Bail Out FTX

The promise of rescue was shortlived as Binance backed out of the deal a day later. On Nov. 9, the exchange said that it would cancel the FTX deal after corporate due diligence raised concerns about the mishandling of customer funds, among other issues.

FTX Assets Frozen and Other Implications

On Nov. 10, the Bahamas securities regulator froze the assets of FTX Digital Markets, FTX’s Bahamian subsidiary, following news that Bankman-Fried was seeking up to $8 billion in capital to bail out the exchange.15 On the same day, the California Department of Financial Protection and Innovation announced that it had initiated an investigation of FTX.

Bankman-Fried apologized the same day for the liquidity crisis and admitted on Twitter that FTX’s non-U.S. exchange had insufficient funds to meet customer demands. Bankman-Fried said that “poor internal labeling” caused FTX to miscalculate leverage and liquidity. In the same thread, he said Alameda would wind down trading.

Bankman-Fried Steps Down as CEO; FTX Files For Bankruptcy

Bankman-Fried stepped down on Nov. 11 as CEO of FTX, replaced by John J. Ray III, who led energy trading firm Enron through bankruptcy proceedings years before.18 FTX filed for Chapter 11 bankruptcy protection the same day, revealing that roughly 130 other affiliated companies were also part of the proceedings. The bankruptcy filings indicated that FTX had assets in the range of $10 billion to $50 billion and liabilities in the range of $10 billion to $50 billion as well.

“Unauthorized Transactions” on FTX

Within hours of filing for bankruptcy, FTX said it was the victim of “unauthorized transactions” and that it would move its digital assets to cold storage for security purposes.20 Outside analysts said they suspect that about $477 million was stolen from FTX in the suspected hack.

Future of FTX and Consequences of Collapse

The future of FTX as a cryptocurrency exchange is in serious jeopardy. As of mid-November 2022, withdrawals are disabled and a notice on the FTX website says the company “strongly advise[s] against depositing.”

The broader consequences of the FTX fiasco for the cryptocurrency industry will also take time to unfold. As the largest collapse in the short history of cryptocurrencies, FTX may further deter investors, who are already cautious because of concerns about stability and security. Customers on the FTX platform may not recover their assets, potentially triggering legal action. The U.S. Securities and Exchange Commission and other regulators may see the collapse of FTX as justification for tightening regulatory scrutiny of cryptocurrencies, and Congress may be more inclined to step in and create new laws governing digital tokens and exchanges.

The stunning collapse of the third-largest exchange by volume will send shockwaves through the crypto universe for some time. Crypto lender BlockFi paused client withdrawals on November 11, 2022, and rumors indicate it may have a dicey future. Crypto.com saw withdrawals increase between November 12 and 13. Genesis Global Capital halted customer withdrawals from its crypto lending unit. And that is likely just the beginning of the collateral damage.

How Did FTX Fail?

FTX filed for bankruptcy on Nov. 11 after a surge of customer withdrawals earlier in the month. CEO Sam Bankman-Fried admitted that the company did not have sufficient assets in reserve to meet customer demand.

Did FTX Get Hacked?

Within hours of filing for bankruptcy, FTX was hacked. The exchange noted “unauthorized transactions” which may have stolen close to $500 million in assets, and which were spotted by Elliptic. The hacker continued to drain wallets for several days using what analysts called “on-chain spoofing.” The hacker reportedly then invested those funds into ether.

What Will Happen to FTX?

As of mid-November 2022, the securities regulator of the Bahamas has frozen FTX’s assets and the company is strongly advising against customer deposits. Other regulatory investigations also are ongoing. And civil lawsuits are being filed. In one such class action lawsuit, FTX founder Sam Bankman-Fried is named along with several celebrities who have promoted FTX in the past, including Tom Brady, Larry David, Naomi Osaka, Shaquille O’Neal, and Stephen Curry.

The Bottom Line

In November 2022, the cryptocurrency exchange FTX collapsed over a period of roughly 10 days. Following a report suggesting potential leverage and solvency concerns, the exchange faced a liquidity crisis and tried to negotiate a bailout by rival Binance that quickly fell through. FTX saw its assets frozen, its CEO resigned, and it filed for bankruptcy within days. The ongoing implications for the future of FTX and the broader cryptocurrency industry are ongoing and difficult to assess.

Source: Investopedia

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